Understanding P/E ratios

We've all heard about P/E ratios, but if it were worth $250,000 for you to explain to Regis Philbin what exactly a P/E was, could you? As you answered price-to-earnings ratio, would it be your final answer? If you said yes, you'd be a winner. But why are they so important in selecting stocks?

The current P/E ratio for any stock is its current share price divided by the last four quarters of the company's accumulated earnings per share. So if the stock's price is $100 and the company earned $5 in the prior four quarters, then its P/E ratio is 20.

The P/E is a simple yet powerful concept that helps gauge how investors feel about a stock and profits it may generate.